CHAPTER – 1

WORKING CAPITAL MANAGEMENT – INTRODUCTION

1.1 Introduction

In every business an optimum level of Working Capital is to be maintained for

the purpose of day to day remittances. Any Business cannot grow in absence
of satisfactory working capital level. In case of shortage of working capital the
business may suffer scarcity of resources. But it should also be kept in mind
that even working capital in excessive quantity, possibly will result into
superfluous cost. Therefore, the management of business firm should goal an
optimal level of working capital. Working capital should be ample enough to
carry out the current liabilities but should not be much more than the genuine
requirement. It must be ensured by the firm’s managing people that the return
yield through the funds engrossed in structuring working capital is no less than
the return earned from other investment alternatives. In the circumstances,
when the financial resources are insufficient and as a consequent capital cost is
to be enlarged, management of working capital becomes even more crucial
and significant due to its profound influence on liquidity and profitability of
the business.

The basic objective of Working Capital Management is to avoid over

investment or under investment in Current Assets, as both the extremes
involve adverse consequences. Over investment in Current Assets may lead to
the reduced profitability due to cost of funds. Working capital management is
considered to be one of the most important functions of finance, as a very
large amount of funds are blocked in current assets in practical circumstances.
Unless working capital is managed properly, it may lead to the failure of
business. The term ‘Working Capital’ may mean Gross Working Capital or
Net Working Capital. Gross Working Capital means Current Assets. Net

1
Working Capital means Current Assets less Current Liabilities. Unless
otherwise specified, Working Capital means Net Working Capital. As such,
Working Capital Management refers to proper management of Current Assets
and Current Liabilities.

The assets which can be converted in the form of cash or used during the
course of normal operations within a short span of time say one year, without
any reduction in value are referred as current assets. Current assets change the
shape very frequently. The current assets ensure smooth and fluent business
operations and are considered to be the life-blood of the business. In case of a
manufacturing organization, current assets may be found in the form of stocks,
receivables, cash and bank balances and sundry loans and advances. The term
current liabilities refer to those liabilities which are to be paid off during the
course of business, within a short span of time say one year. They are expected
to be paid out of current assets or the earnings of the business. Current
liabilities consist of sundry creditors, bills payable, bank overdraft or cash
credit, outstanding expenses etc.

The objective of Working Capital Management is to ensure Optimum

Investment in Current Assets. In other words, Working Capital Management
intends to ensure that the investment in Current Assets is reduced to the
minimum possible extent. However, the normal operations of the organization
should not be affected adversely. If the normal operations of the organization
are affected adversely, reducing the investment in Current Assets is fruitless.

Generally, it will not be possible for any organization to operate without the
working capital. Let us assume that a manufacturing organization commences
its business with a certain amount of cash. This cash will be invested to buy
the raw material. The raw material purchased will be processed with the help
of various infrastructural facilities like labor, machinery etc. to convert the
same in the form of finished products. These finished products will be sold in

2
the market on credit basis whereby the receivables get created. And when
receivables make the payment to the organization, cash is generated again. As
such, there is a cycle in which cash available to the organization is converted
back in the form of cash. This cycle is referred to as Working Capital Cycle.

In between each of these stages, there is some time gap involved. The entire
requirement of working capital arises due to this time gap. As this time gap is
unavoidable, requirement of working capital is unavoidable. The finance
professional is interested in reducing this time gap to the minimum possible
extent in order to manage the working capital properly. Business can survive
even if profits are not made but it may not survive without proper liquidity.
Hence, in order to retain the liquidity state, all business firms should manage
their working capital appropriately.

Working Capital Management

Relation between Current assets and current liabilities of a business firm is

called management of working capital. “Working capital management is
concerned with the problems that arise in attempting to manage the current
assets and current liabilities and the inter-relationship that exists between
them. There is habitually a distinction made amid the investment decisions
concerning current assets and the financing of working capital.”

Two major aspects of management of working capital are:

(1) To ascertain the current assets

(2) To conclude the method of financing

1.2 Concept of Working Capital Management

Working capital management can be conceptualized under two categories:

3
  Quantitative and
 Qualitative

These concepts are well known as “gross working capital” concept and “net
working capital” concept. In quantitative working capital concept, current
assets are considered as working capital which is termed as gross working
capital too. In qualitative, current assets and current liabilities are taken into
account, working capital is defined as excess or deficit of current assets over
current liabilities. “Variance of current assets over current liabilities” L.J.
Guthmann also described working capital as “the portion of a firm’s current
assets which are financed from long–term funds.”

It becomes essential to know and understand the current assets components

and current liabilities components to understand working capital management.

Current assets – This is imperative to facilitate “Current assets have a short

life span. These types of assets are connected in current operation of a
business and normally used for short–term operations of the firm. The two
important characteristics of these assets are; (i) short life span, and (ii) swift
conversion into other form of assets. Cash balance may be held idle for few
weeks, account receivable may have a period of 30 to 60 days”

Fitzgerald also described current assets, “cash & other assets which are
expected to be converted in to cash in the ordinary course of business within
one year or within such longer period as constitutes the normal operating cycle
of a business.”

Current liabilities – Business generates liability for purchasing raw material

and other essential things on credit, these are called as creditors or account
payable. Until remittances towards creditors are made, it is categorized under
liabilities section of balance sheet. Current liabilities are explained as all
obligations that are due in near future for payment.

4
1.3 Working Capital Structure

Various current assets and current liabilities components make up the working
capital composition. Each component plays important part in any business
firm. If any component of working capital is not adequate, it may bring down
efficiency and profitability of the company. Current asset and current
liabilities which constitute working capital structure are shown in table 1.1

Table 1.1
Working Capital Structure

Current Liabilities Current Assets

Creditors Inventories
Bank Overdraft Cash and Bank Balance
Bills Payable Accounts Receivables
Outstanding Expenses Bills Receivables
Short-term Loans Accrued Income
Provision for Taxation Prepaid Expenses
Other Current Liabilities Other Current Assets

1.4 Working Capital Circulation

Current assets along with current liabilities present in all the businesses every
time. It’s like stimulating current which flow every time. “Working capital
plays pivotal role of heart in any firm as in human body. Working capital
resources are created and distributed in the business firm, and if circulation of
working capital stops, business tends to get unresponsive.” It is very essential
to circulate resources to enable long life and efficient run of any business.

Chart 1.1 depicts cycle of working capital which represents it very apparent so
as to the overall cash is gathered primarily through issuance of shares or
debentures, borrowings as well as operation. Cash is utilized in the direction of

5
procuring raw material, fixed assets and paying due amount to creditors. Raw
materials then processed; operating expenses are paid that further results in
production of finish product up for sale.

Chart 1.1
Working Capital Cycle

Work in
Progress

Wages Expenses

Finished
Material
Goods
Fixed
Assets

Creditors for Debtors for

Goods Goods

Cash

Tax
Issue of Borrowing Fund from Interest
Shares operation Dividend

The finished product is sold either for cash or credit. For cash sales, cash is
straightforwardly recorded by business while in case of credit sales, collection
of cash happened later from the buyers. Cash is generated through operations
as well as through fixed assets sale. Certain part of profit used for all kind
payment related to business while residual is kept in the business firm. Cycle
continues all the way through the life of the firm.

6
1.5 Importance of Working Capital Management

Fund or cash is required in business for carrying out operations. “Working

capital finances can be regarded as ‘life blood’ of a business firm. Business
can live with no profit but can’t survive with inadequate working capital. If a
business is not yielding gains it can be called as ‘sick’, although without
adequate working capital the firm could suffer its economic failure and the
survival becomes difficult. Thus, every business firm should make a decision
how to arrive at right amount of working capital, to avoid risk of breakdown.”

Working capital management is having immense significance and became

prime object to enhance liquidity and profitability of the business. With
constant increase in capital costs and scarcity of funds, management of
working capital is the most vital subject capturing attention of management. It
is found that, “Regular management review is required to maintain suitable
level in the diverse working capital accounts.” Success of business mainly
depends on appropriate working capital management that is why “working
capital management is looked upon as the driving seat of financial manager.”
It takes time to enhance profitability and ensuring adequate liquidity
simultaneously.

1.6 Working Capital Estimation

Working capital may be estimated by following methods:

• Proportion of Sales – This method is the easiest way of deciding the

requirement of working capital. Requirement of working capital in this
method is determined on forecasting of sales. With the help of historical
experience, working capital requirement can be projected. If relationship of
working capital and sales is stable, then ratio is taken as a base for deciding
the amount of working capital required. This method of estimating working
capital is simple, tranquil and helpful in estimating working capital.

7
• Operating Cycle – All business starts with raw material acquisition,
machinery and stock at the time of collection of dues. It might be part in these
stages:

 Raw material
 Work in Progress
 Finished product
 Receivable

The operating cycle length for the objective of working capital estimation is
equivalent to summation of durations of each stage minus credit period
permissible by the service or raw material provider.

• Regression Analysis Method – This is a statistical technique to forecast

requirement of working capital. It aids in projections post setting up the
relationship in earlier years between variables such as working capital and
sales. Analysis is done through mathematical formulae or through the graphic
representations scatter diagram. The bond between variables (working capital
and sales) is simple & direct revealing linear relation with different degrees
relating linear regression or curvilinear regression and multiple regression
situations.

1.7 Variables Impacting Need of Working Capital

Various factors influence volume and requirement of working capital. Hence

determining working capital does not have a set formula or particular way.
The condition and information of company must be analyzed to conclude the
requirement of working capital.

Below are the factors which influence requirement of working capital:

8
Nature of business – Some businesses are such that due to their very nature,
their requirement of fixed capital is more rather than working capital. These
businesses may sell services and not the commodities and that too on cash
basis. As such, no funds are blocked in piling the inventories and no funds are
blocked in receivables. For example Public utility services like railways,
electricity boards, and infrastructure oriented projects etc. Their requirement
of working capital is less. Whereas if the organization is a trading
organization, the requirement of working capital will be on the higher side, as
huge amount of funds get blocked in mainly two types of current assets, stock
and receivables.

Size of the Organization – If we talk about undersized scale organizations,

because of huge overheads total, the necessity of working capital gets really
high. It is also influenced by high purchase costs as well as high selling costs.
As such, medium sized organizations have an edge over the small scale
organizations. However, if the business grows beyond a certain limit, the
requirement of working capital may be adversely affected by the increasing
size.

Phase of Trade Cycles – During the inflationary conditions, the working

capital requirement will be on the higher side as the company may like to buy
more raw material, may increase the production to take the advantage of
favorable market conditions and due to increased sales more funds are blocked
in stocks and receivables. During the depression, the requirement of working
capital will be on the lower side due to reduced operations but more working
capital may be required due to piling up of inventories and due to non-
payment of dues by customers in time. As such, in both the extreme situations
of trade cycles, requirement of working capital may be high.

Trading Terms – The terms on which the organization makes the purchases
and sales affect the requirement of working capital in a big way. If the

9
purchases are required to be made on cash basis and sales are to be made on
credit basis to cope with competition existing in the market, it will result into
high requirement of working capital. Whereas, if the purchases can be made
on credit basis and sales can be made on cash basis, it will trim down the
prerequisite of working capital, as a part of working capital requirement can
be financed out of credit offered by the suppliers.

Length of Production Cycle – The term production cycle refers to the time
duration from the stage raw material is acquired till the stage finished product
is manufactured. The principle will be “Longer the duration of production
cycle, higher the requirement of working capital.” In some businesses like
machine tool industry, the time gap between the acquisitions of raw material
till the completion of production is quite high. As such, more amounts are
blocked in raw materials or work in progress or finished goods and even in
receivables. Requirement of working capital is always very high in this case.

Profitability – High profitability reduces the strain on working capital as the

profit to the extent they are earned in cash can be used for financing the
requirement of working capital. However, the profit which reduces the strain
on working capital is the post-tax profit i.e. the profit earned after paying off
the tax liability and Post-dividend profit i.e. the profit remaining in the
business after paying the dividend on the shares.

1.8 Control of Working Capital

Working capital needs used to be met mainly in the form of cash credit
facilities and these advances used to be totally security oriented rather than
end-use oriented. As such, the units which were able to provide securities to
the banks were able to get main chunk of the finances provided by the banks
whereas others experienced shortage of inputs, lower capacity utilization, high
cost of production and ultimately threat of closure. Reserve Bank of India

10
attempted to detect weakness in financing of working capital needs through
Banks with the purpose of control the working capital finance. Attempts were
made through these committees:

(a) Dahejia Committee

(b) Tandon Committee

(c) Chhore Committee

(d) Marathe Committee

(e) Nayak Committee and Vaz Committee

Work of these committees is described as below:

(a) Dahejia Committee

This committee was assigned in October, 1968 to assess the extent credit need
of trade and industry are expected to be overstated and how these movement
could be assessed.

Committee has found out that it is the tendency of trade to get short term loan
from Banks far above growth rate discovered in production for inventory in
terms of value. It also found that purchase of long-term asset has been done
through short-term bank loan. The reason for this is that generally banks
granted working capital finance in the form of cash credit, as it was easy to
operate. Banks took into consideration security offered by the client rather
than assessing financial position of the borrowers. As such, loan facility given
by the banks was not used for short term purposes.

Recommendations: The committee, firstly, recommended that the banks

should not only be security oriented, but they should take into consideration

11
total financial position of the client. Secondly, it recommended that all loan
accounts are categorized in two parts:

i) Hard core loan accounts - Represent the least level of raw material, finished
product and stores items which is required by any industry to store for keeping
definite level of production.

ii) Short-term loan accounts - Elements that makes out the funds for
provisional purposes i.e. Short-term increase in inventories, tax, dividend and
bonus payments etc.

It also suggested that hard core part in case of sound financial companies must
be put on a time loan basis focused to schedule of repayment. In other cases,
borrowers should be asked to arrange for long term funds to replace bank
borrowings.

In practice, recommendations of the committee had only a marginal effect on

the pattern and form of banking.

(b) Tandon Committee

In August 1975, Reserve Bank of India appointed a study group in the

supervision of Mr. P. L. Tandon, to make the research and recommendations
on the following issues:

i) Can the norms be developed for current assets as well as for debt
equity ratio to make sure least reliance on bank finance?
ii) How the amount of bank loans may be concluded?
iii) Can the existing way and method of financing be made further
superior?

12
iv) Can sufficient planning, appraisal and information system be
developed to make sure a disciplined loan process to meet up genuine
production requirement and its supervision?

The observations and recommendations made by the committee can be

considered as below:

(1) Norms: The committee suggested the norms for inventory and accounts
receivables for as many as 15 industries excluding heavy engineering industry.
These norms suggested, represent maximum level of inventory and accounts
receivables in each industry. However if the actual levels are less than the
suggested norms, it should be continued.

The norms were suggested in the following forms:

- For Raw Materials: Consumption in months

- For Work in Progress: Cost of production in months

- For Finished Goods: Cost of Sales in months

- For Receivables: Sales in months

It was clarified that the norms suggested cannot be absolute or rigid and the
deviations from the norms may be allowed under certain circumstances.

It also concluded that the terms should be reviewed regularly.

It was recommended that trade borrower having a limit of more than Rs. 10
Lacs from the Banks should be subjected to these terms initially and then later
on it should be extended even to the small borrower.

(2) Methods of Borrowings: Committee suggested that amount of bank loan

shouldn’t be determined by the capability of the borrower to secure banks but

13
it must be determined to complement the borrower’s resources in carrying a
rational level of current assets to meet his requirement of production. For the
same purpose, it initiated the concept of gap in working capital i.e. the surplus
of current assets over current liabilities other than bank loan. It also
recommended progressive methods to determine the maximum permissible
limits to be followed by banks to provide credit.

Method I - Committee suggested banks should provide loan maximum 75% of

gap of working capital, rest 25% should arise from long term funds i.e. own
funds and term borrowings.

Method II - Committee in this method recommended that the borrowers

should get finance equal to 25% of current assets through long term funds and
remaining amount should be financed by banks.

Method III – In this method, committee established the core current assets
concept to point out permanent proportion of current assets and suggested the
borrowers should finance entire requirement of core current assets and 25% of
remaining current assets through long term funds and banks might provide the
remaining amount.

It can be observed from above that the gradual implementation of these

methods will reduce the dependence of borrowers on bank finance and
improve their current ratio. The committee suggested that the borrowers
should be gradually subjected to these methods of borrowings from first to
third.

However, if the borrower is already in second or third method of lending, he

should not be allowed to slip back to first or second method of lending
respectively.

14
It was further suggested that if the definite bank borrowings are more than the
upper limit of allowable bank borrowings, the excess is ought to be converted
into a term loan to be amortized above a suitable stage depending upon the
cash generating capacity.

(3) Style of Lending: The committee suggested changes in the manner of

financing the borrower. It suggested that the cash credit limit should be
bifurcated into two components i.e. Minimum level of borrowing required
throughout the year should be financed by way of a term loan and the demand
cash credit to take care for fluctuating requirements. It was suggested that both
these limits should be reviewed annually and that the term loan component
should bear a slightly lower rate of interest so that the borrower will be
motivated to use the least amount of demand cash credit. The committee also
suggested that within overall eligibilities, a part of the limits may be in the
form of bill limits (to finance the receivables) rather than in the form of cash
credit.

(4) Credit Information Systems: In order to ensure the receipt of operational

data from the borrowers to exercise control over their operations properly, the
committee recommended the submission of a quarterly reporting system,
based on actual as well as estimations, so that the requirements of working
capital possibly will be estimated depending on the production needs. As such,
borrowers enjoy total credit limits aggregating Rs. 1 Crore and above were
required to submit certain statements in addition to monthly stock statements
and projected balance sheet and profit and loss account at the end of the
financial year. The working capital limits sanctioned were to be reviewed on
annual basis. Within the overall permissible level of borrowing, the day to day
operations were to be regulated on the basis of drawing power

(5) Follow up, Supervision and Control: In order to assure that the
assumptions made while estimating the working capital needs still hold good

15
and that the funds are being utilized for the intended purpose only, it was
suggested that there should be a proper system of supervision and control.
Variations between the projected figures and actual may be permitted to the
extent of 10%, but variations beyond that level will require prior approval.
After the end of the year, credit analysis should be done in respect of new
advances when the banks should re-examine terms and conditions and should
make necessary changes. For the purpose of proper control, it suggested the
system of borrower classification in each bank within a credit rating scale.

(6) Norms for Capital Structure: As regards the capital structure or debt equity
ratio, the committee did not suggest any specific norms. It opined that debt
equity relationship is a relative concept and depends on several factors. Instead
of suggesting any rigid norms for debt equity ratio, the committee opined that
if the trend of debt equity ratio is worse than the medians, the banker should
persuade the borrowers to strengthen the equity base as early as possible.

Action Taken by RBI

According to the notification of RBI dated 21st August, 1975, Reserve Bank of
India acknowledged many recommendations suggested by the committee.

(1) Norms for Inventories and Receivables: Norms suggested by the

committee were accepted and banks were instructed to apply them in case of
existing and new borrowers. If the levels of inventories and receivables are
found to be excessive than the suggested norms, the matters should be
discussed with the borrower. If excessive levels continue without justification,
after giving reasonable notice to the borrowers, banks may charge excess
interest on that portion which is considered as excessive.

(2) Coverage: Initially, all the industrial borrowers (including small scale
industries) having aggregate banking limits of more than Rs. 10/- Lacs should
be covered, but it should be extended to all borrowers progressively.

16
(3) Methods of Borrowing: RBI instructed the banks that all the covered
borrowers must be positioned in method I the same as recommended as a
result of the committee discussion. However; all those borrowers who are
already complying with requirements of Method II should not slip back to
Method I. As far as Method III is concerned, RBI has not taken any view.
However, in case of the borrowers already in Method TI, matter of application
of Method III may be decided on case to case basis.

(4) Style of Credit: As suggested by the committee, instead of granting entire

facility by way of cash credit, banks may differentiate the limit as (i) Term
loan to take care of permanent requirement and (ii) fluctuating cash credit.
Within the overall limits, bill limits may also be considered.

(5) Information system: Suggestions made by the committee regarding the

information system were accepted by RBI and were made applicable to all the
borrowers having the overall banking limits of more than Rs. 1 crore.

(c) Chhore Committee:

In April 1979, Reserve Bank of India appointed a study group under the
chairmanship of Mr. K.B. Chhore for the purpose, of evaluating mainly the
loan granting procedure management strategy of banks.

The annotations as well as the recommendations made by the committee can

be discussed as below:

(1) An increasing functionality of short-term cash credits as well as financing

of bills has been recommended by the committee. Restricting the role of cash
credit limits was also recommended by the committee.

(2) The committee recommended that the borrowers are supposed to require
and improve their own involvement in the working capital. In isolation, they

17
must fall under Second Method of lending as being suggested by Tandon
Committee. In case the real borrowings are in greater than maximum
allowable borrowings as described by Method II, the surplus portion is to be
reassigned under Working Capital Term Loan (WCTL) and the borrower
should repay it by half annually installments within a tenure of maximum 5
years. Interest on WCTL should usually be higher than of interest on cash
credit facility.

(3) The committee has suggested that the efforts should be made to inculcate
further discipline as well as planning awareness among the borrowers; their
requirement should be fulfilled on the basis of periodical projections deposited
by them. Surplus or under employment beyond acceptable limit of 10% which
is to be treated as irregularity and combined action must be taken.

(4) The committee has recommended that the banks must appraise and also
decide different limits for regular non-peak levels and peak levels too. It must
be preceded in reference to all borrowers availing the banking credit limit of
greater than Rs. 10 Lacs.

(5) The committee suggested that the borrowers must be dispirited from
impending the banks recurrently for ad hoc as well as temporary limits in
overindulgence of limits to meet up unforeseen contingencies. Requests for
such limits should be considered very carefully and should be sanctioned in
the form of demand loans or non-operating cash credit limits. Additional
interest of 1% p.a. should be charged for such limits.

(d) Marathe Committee

In 1982, Reserve Bank of India appointed a study group known as Marathe

Committee to review the Credit Authorization Scheme (CAS) which was in
existence since 1965. Under CAS, the banks were required to take the prior
approval of RBI for sanctioning the working capital limits to the borrowers.

18
As per Marathe Committee recommendations, in the year 1988, CAS was
replaced by Credit Monitoring Arrangement (CMA) according to which the
banks were supposed to report to RBI, sanctions or renewals of the credit
limits beyond the prescribed amounts for the post-sanction scrutiny.

(e) Nayak Committee and Vaz Committee:

Recently, RBI has accepted the recommendations made by Nayak Committee.

This was with the intention to recognize the contribution made by the SSI
Sector to the economy.

According to Nayak Committee recommendations, for evaluating working

capital necessities of village industries, small scale industries and new SSI
units having the overall fund based working capital limits up to Rs. 50 Lacs,
the norms for inventory and receivables as suggested by Tandon Committee
will not apply. The working capital need of these units may be measured to be
25% of their anticipated turnover (for both new as well as existing units); out
of which 20% is believed to be initiated by the units like their margin money
requirements and remaining 80% can be financed by the bank. In other words,
there are 4 working capital cycles assumed in every year.

Vaz Committee has comprehended the suggestions given by Nayak

Committee to each and every business organizations. It was also
acknowledged by Reserve Bank of India.

As a result of Nayak Committee and Vaz Committee recommendations,

projected turnover of the borrowers is the basis for evaluating the working
capital requirement. Out of the projected turnover, 5% is supposed to be
introduced by the borrower in the form of own contribution and remaining
20% can be financed by the bank. The requirement of working capital has
nothing to do with the level of current assets and current liabilities, which was
the basis of Tandon Committee and Chhore Committee recommendations.

19
Evaluation of working capital requirements by the banks relaxed with the
intention to give greater autonomy to the banks while evaluating working
capital requirement, RBI has officially withdrawn the concept of MBPF with
effect from 15th April, 1997. As a result, now the banks are free to have their
own methods for evaluating the working capital requirement of the borrowers.

1.9 Source of Working Capital

Source of working capital is very important as it’s important to keep business

liquid as well as stress free from financial burden. Basic current assets
requirement must be met with long term sources and current assets which are
required for circulation should be met with short term sources. It benefits
business by keeping cost of capital low and increases return on investment.
There are two kinds of working capital involved in any business:
a) Fixed or Permanent Working Capital
b) Variable or Temporary Working Capital

Fixed Working Capital is the minimum working capital required to be

maintained in the business on permanent or uninterrupted basis. The
requirement for this type of working is unaffected due to the changes in the
level of activity. The relationship between fixed and variable working capital
can be shown with the help of the following diagram.
Chart 1.2
Fixed and Variable Working Capital

20
Variable working capital is the working capital required over and above the
fixed or permanent working capital and changes with the fluctuations in the
level of activity as a result of changes in production and sales.

The basic principle of finance states that the permanent requirement of

working capital should be financed out of long term or permanent sources i.e.
own generation of funds, cash profits, shares or debentures etc.

For financing temporary requirement of working capital, the organization can

go for various sources which can be discussed as below:

a. Spontaneous Sources

b. Inter-Corporate Deposits

c. Commercial Papers

d. Banks

The selection of source is very important as it determines the level of liquidity

and flexibility in any business firm.

a. Spontaneous Sources

Spontaneous Sources for financing the working capital requirement arise

during the course of normal business operations. During the course of business
operations, the company may be able to buy certain goods or services for
which the payment is to be made after a certain time gap. As such, the
company is able to buy goods or services without making payment for the
same. These spontaneous sources are unsecured in nature and vary with the
level of sales. These spontaneous sources do not have any explicit cost
attached to the same. They are generally known as ‘Current Liabilities.’

21
Following forms of current liabilities may be used as spontaneous sources for
financing the working capital requirement.

1. Trade Credit:

If the company buys the raw material from the suppliers on credit basis, it gets
the raw material for utilization immediately with the facility to make the
payment at a delayed lime. By accepting the delayed payment, the suppliers of
raw material finance the requirement of working capital. For using this source,
certain factors may play an important role:

• Trends in the industry

• Liquidity position of the company

• Earnings of the company over a period of time

• Record of payment by the company to the suppliers

• Relationship of the company with the suppliers.

2. Outstanding Expenses

All the services enjoyed by the company are not required to be paid for
immediately. They are paid for after a certain time gap. As such, the company
is able to get the benefit of these services without paying for the same
immediately, thus getting the finance for working capital purposes. These are
called ‘outstanding expenses’. This may apply to salaries, wages, telephone
expenses, electricity expenses, water charges etc.

b. Inter-Corporate Deposits (lCD)

Inter-corporate Deposits indicate the amount of funds borrowed by one

company from another company, usually both the companies being under the

22
same management but not necessarily so. Point to be noted here is that ICDs
are not considered to be deposits as stated by the provisions of Section 58-A of
the Companies Act, 1956 and in isolation the set of laws pertinent to the
public deposits does not affect the ICD’s.

Inter-corporate Deposits as a source for financing the working capital

requirement has the following characteristic features.

 ICD is for a very short period of time, i.e. three months or six months.
 ICD is an unsecured source for raising the funds required for working
capital purposes.
 ICD as a source is not regulated by any law. As such, the rate of interest,
period of lCD etc. can be decided by the company on its own.
 ICD is a relationship based borrowing made by the company.

c. Commercial Papers

In the earlier period, Commercial Papers (CPs) have turned one of the most
excellent mode for financing the working capital obligations of the companies.
The companies demanding to raise the funds through issue of Commercial
Papers are being regulated by guiding principles for issue of Commercial
Papers issued by RBI on 10th October year 2000. These guiding principles
apply to the companies those are making efforts to increase the funds by
issuing the CPs. According to, these guidelines, a company means a company
as described in Section 45-I (aa) of Reserve Bank of India Act, 1934. Section
45-1(aa) of Reserve Bank Act, 1934 defines a company as the company as
defined in section 3 of the Companies Act, 1956.

d. Banks

The scenario of India is structured in a way where, banks play exceedingly

significant role in financing the working capital requirement of a business

23
firm. Banks are considered as a foundation for financing the working capital
requirement of the organizations on the basis of below mentioned points:

 What should be the amount of assistance?

 b. What should be the form in which working capital assistance is
extended?
 c. What security should be obtained for working capital assistance?
 d. What are the various applicable regulations to be considered by the
banks while extending the working capital assistance?

Quantum of Assistance

A business firm is firstly mandated to measure and calculate its requirement of

working capital appropriately in order to acquire the bank credit for financing
the working capital requirements. And for estimating the working capital
requirement optimally, the business firm should primarily estimate the current
assets and current liabilities level, because working capital is the difference
between the amount of current assets and of current liabilities. To calculate the
values of optimum working capital, techniques like ratio analysis, trend
analysis etc. could be implemented on data of the company. The accuracy
level of estimating the current assets as well as current liabilities decide the
accuracy of evaluating the requirement of working capital level. Then, the
business firm would have to move towards the bank along with the essential
sustaining financial data. On the basis of the anticipated figures submitted by
the concern, the bank decides the quantum of assistance level which is to be
unmitigated. The bank prescribes the margin money required at the time of
extending the working capital assistance. The margin money specification is
fixed by the banks in accordance to make sure the borrowing company’s
individual stake in the business in addition to provide the safeguard against the
probable diminution in the value of security presented to the bank. The
fraction of margin money specification might depend in the lead of credit

24
reputation of the borrowing firm, variations in the price of the security
moreover, the time to time directives of RBI. The common principle validated
will be, “more dicer the nature of security, higher will be the margin money
stipulations.”

Assistance structure:

The bank will be able to disburse the amount in one of the subsequent forms,
after deciding the amount of total assistance that can be extended for the
business firm:

a. Non-Fund Based Lending

Considering Non-Fund Based Lending, the lending bank does not entrust any
substantial outflow of funds. Therefore, the funds arrangement of the lending
bank remains integral. The Non- Fund Based Lending could be done by the
banks through these two ways:

i. Bank Guarantees:

The bank guarantees mechanism is described below:

Suppose Company A is the selling company and Company B is the purchasing

company. Company A does not know Company B and as such is concerned
whether Company B will make the payment or not. In such circumstances, D
who is the Bank of Company B, opens the Bank Guarantee in favor of
Company A in which it undertakes to make the payment to Company A, if
Company B fails to honor its commitment to make the payment in future. As
such, interests of Company A are protected as it is assured to get the payment,
either from Company B or from its Bank D. As such, Bank Guarantee is the
mode which will be found typically in the seller’s market. As far as Banks is
concerned, while issuing the guarantee in favor of Company A, it does not

25
commit any outflow of funds. As such, it is a Non-Fund Based Lending for
Bank D. If on due date, Bank D is required to make the payment to Company
A due to failure on account of Company B to make the payment, this Non-
Fund Based Lending becomes the Fund based Lending for Bank D which can
be recovered by Bank D from Company B. For issuing the Bank Guarantee,
Bank D charges the Bank Guarantee Commission to Company B which gets
decided on the basis of two factors i.e. what is the amount of Bank Guarantee
and what the period of validity of Bank Guarantee is. In case of this
conventional form of Bank Guarantee, both Company A as well as Company
B gets benefited. Company A is benefited as it is assured to get the payment.
Company B is benefited, as it is able to make the credit purchases from
Company A without knowing Company A. As such, Bank Guarantee
transactions will be applicable in case of credit transactions.

In some cases, interests of purchasing company are also to be protected.

Suppose that Company A which manufactures capital goods takes some
advance from the purchasing Company B. If Company A fails to fulfill its part
of the contract to supply the capital goods to Company B, there needs to be
some protection available to Company B. In such circumstances, Bank C
which is the banker of Company A opens a Bank Guarantee in favor of
Company B in which it undertakes that if Company A fails to fulfill its part of
the contract; it will reimburse any losses incurred by Company B due to this
non-fulfillment of contractual obligations. Such Bank Guarantee is technically
referred to as Performance Bank Guarantee and is ideally found in the buyer’s
market.

ii. Letter of Credit

The non-fund based lending by the way of Letter of Credit (LC) is incredibly
found in the international business regularly. Under this, the exporter and
importer are anonymous with each other. Due to this reason, the exporter

26
remains in dilemma about getting the disbursement from the importer at the
same time, the importer gets worried about whether he will get a hold of goods
or not. In order to solve this problem, the importer applies to his bank in his
own country to release a letter of credit in name of the exporter whereby, the
importer’s bank assures to pay the exporter or allow the bills or drafts drawn
by the exporter on the exporter gratifying the provisions and stipulations
specified in the letter of credit.

Fund based lending

In the matter of Fund Based Lending, the lending bank supports the substantial
outflow of funds. The funds position of the lending bank gets pretentious
because of this reason. The Fund Based Lending is done by the banks using
the following methods:

(1) Loan: Disbursement of the total amount of assistance is made at one time
simply under this case, either in cash or through transfer in company’s
account. It is a solitary proceed. The loan might be reimbursed in installments,
and the interest would be charged on outstanding amount.

(2) Overdraft: In this scenario, the firm is permitted to withdraw in surfeit of

the balance remaining in its Bank account. Though, a fixed limit is specified
by the Bank ahead of which the firm is not able to overdraw from the account.
Conceding of the assistance by the way of overdraft presupposes the opening
of a prescribed current bank account. Officially, overdraft is an on demand
assistance granted by the bank that means the bank can ask over the settlement
at any moment of time. Overdraft is facilitated by the bank for a very short
duration of time, at the end of which the business firm is thought to pay back
the amount. Interest gets due on the actual amount drawn and is estimated on
daily product basis.

27
(3) Cash Credit: Actually, the proceedings in cash credit facility are same as in
those of bank overdraft facility other than the fact that the firm does not
require to open a formal current account. In this case as well a fixed perimeter
is stipulated beyond which the firm cannot withdraw the amount. Legally,
cash credit is too a demand facility, but in real, it is on incessant basis. Under
cash credit also, the interest is allocated on the actual amount drawn and is
deliberated on daily product basis.

(4) Bills Purchased/Discounted: This form of assistance is comparatively of

recent origin. This facility enables the company to get the immediate payment
against the credit bills/invoices raised by the company. The bank holds the
bills as a security till the payment is made by the customer. The entire amount
of bill is not paid to the company. The company gets only the present worth of
the amount of the bill, the difference between the face value of the bill and the
amount of assistance being in the form of discount charges. However, on
maturity, the bank collects the full amount of bill from the customer. While
granting this facility to the company, the bank inevitably satisfies itself about
the credit worthiness of the customer and the genuineness of the bill. A fixed
perimeter is specified in case of the company, further than which the bills are
not purchased or discounted by the bank.

(5) Working Capital Term Loans: In accordance to match up the working

capital requirement of the business firm, banks possibly will grant the working
capital term loans for a time period of 3 years to 7 years, payable both in
yearly installments or half yearly installments.

(6) Packing Credit: This kind of assistance can be granted by the bank on the
way to take concern of particular requirement of the company at the time it
avails any export order. To facilitate the company in buying or manufacturing
the goods to be exported, packing credit facility is given by the bank. In case
the company holds a confirmed export order given by the international buyer

28
or an irretrievable letter of credit in the favor of company, the company can
approach the bank to avail packing credit assistance.

c. Security for Assistance:

The bank may possibly be able to give the assistance in either of the modes as
mentioned above. However, no assistance would be accessible until the
company presents any kind of security out of these:

1) Hypothecation: Under this mode of security, the bank extends the assistance
to the company against the security of movable property, usually inventories.
Under this mode of security neither the property not the possession of the
goods hypothecated is transferred to the bank. But the bank has the right to
sell the goods hypothecated to realize the outstanding amount of assistance
granted by it to the company.

2) Pledge: Under this mode of security, the bank extends the assistance to the
company against the security of movable property, usually inventories. But
unlike in case of hypothecation, possession of the goods is with the Bank and
the goods pledged are in the custody of the bank. As such, it is the duty of the
bank to take care of the goods in its custody. In case of default on the part of
company to repay the amount of assistance, the bank has the right to sell the
goods to realize the outstanding amount of assistance.

3) Lien: Under this mode of security, the bank has a right to retain the goods
belonging to the company until the debt due to the bank is paid.

4) Mortgage: This mode of security pertains to immovable properties like land

and buildings. It indicates transfer of legal interest in a specific immovable
property as security for the payment of debt. Under this mode, the possession
of the property remains with the borrower while the bank gets full legal title
there, subject to borrower’s right, to repay the debt. The party who transfers

29
the interest (i.e. the company) is called mortgager and the party in whose favor
the interest is so transferred (i.e. the bank) is called mortgagee.

1.10 Study and Methodology

Success or failures of any business rely on kind of administration is happening

with working capital. Proper management of working capital gives an edge to
business and helps it attain efficiency. Shortage of working capital is key
reason of failures of many business firms. However, mismanagement of
working capital resources can also be prime reason of business success or
failure. “Inadequacy of working capital is a symptom, and sometimes an
excuse of business failure.” The appropriate working capital management is
sufficient amount of working capital along with proper management of each
component of working capital.

Methodology – Several cement companies are present in Rajasthan. Final

chosen companies are decided basis core cement business and size of cement
operations. Annual reports for financial data of these companies accumulated
from the official website of each selected cement companies. Some statistical
techniques and computer software have been used to analyze the collected
data. The analysis, findings, conclusion, recommendations and suggestions
have been offered in the study.

Analysis of methods – Many reasons make it necessary to analyze position of

working capital in a business firm. It facilitates management to recognize
trends and adopt remedial steps if required. It also helps to record the changes
business has taken and its impact to use it as future tool for improvement. Two
major tools to analyze and determine position of working capital of a business
are:

1. Ratio Analysis – This technique provides analysis of each and every

component of working capital. Every aspect of working capital can be

30
captured in this method. Ratio of one component to another component is
computed and results are extracted with comparison against standards. This
technique also helps to understand whether the working capital components
are adequate or short or excessive as per the requirement.

2. Funds Flow Analysis – This analysis helps to examine change in working

capital and its components. Difference of current assets and current liabilities
at the start the financial year with current assets and current liabilities at the
end of the financial year, it exhibits change in every current assets and current
liabilities. However, it doesn’t conclude on whether right set of working
capital is employed and how is it used to take corrective steps to improve
liquidity and profitability.

1.11 Purpose and Scope of Study

The current study “Working Capital Management in Cement companies of

Rajasthan” examines the effectiveness of management of working capital
components i.e. cash & bank balance, inventory, receivables and current
liabilities components. Study tries to verify the usefulness and efficiency of
managing all segments of working capital. Net working capital model is
considered in the study, current assets components and current liabilities
components and its management is also appraised.

The way current assets as well as current liabilities are organized; it

determines the extent of accomplishment or collapse of a business firm.
Management of working capital involves the administration of components of
current assets and current liabilities.

Therefore, the firm needs to optimize use of existing resources by efficient

management of components of current assets and current liabilities. It enables
business to increase in profitability and it will be capable to pay its obligation
promptly.

31
1.11.1 Hypotheses of the study

The study is pursued to check the hypotheses with reference to Cement

companies of Rajasthan:

H01 There is no significant relationship between working capital

management & profitability of the cement manufacturing units under
the research study.

H02 The working capital management of the selected cement

manufacturing units under study is not satisfactory.

H03 The level of inventory, cash and bank balance as well as performance
of receivable management is not satisfactory.

1.11.2 Objectives of the study

The primary objective of current study is to assess and examine the

management of working capital in top cement industries in Rajasthan, inspect
the inventory levels, cash balances, liquidity and debtor’s management. It will
also find the relationship exist between Working Capital and Profitability.

The aim of the study is to evaluate numerous concepts of management of

working capital and capture the feasibility of the concept of working capital
with aspiration to improve control and planning of working capital. Problems
of management of working capital include determining of optimum level of
amount required in every component of current assets i.e. receivables,
inventory, cash & bank and other short-term investment. Fundamental focus in
management of working capital should be to make optimum use of firm's
investment. Crisis of working capital is major factor accountable for low
profitability in all type of business. Better control and planning of
management of working capital or appropriate utilization of quantity of

32
working capital enhances the ability to earn profit subject to existence of
margins.

The study is commenced to accomplish the objectives with respect to

management of working capital in Cement companies of Rajasthan:

1) To study and appraise management of working capital of selected

cement companies
2) To assess inventory level, cash & bank and performance of
receivable management
3) To compare selected cement units regarding working capital
management
4) Recommend basis conclusions in the working capital management
in Cement companies of Rajasthan
5) To distinguish impact of working capital on profitability of cement
companies

1.11.3 Selection of Companies

In present study, shortlisted cement companies are:

1. ACC

2. Ambuja Cement

3. Shree Cement

4. India Cement

5. Ultratech Cement

33
The companies are selected basis size and capital employed also these
companies core business should also be related to cement. Comparative study
is done through pragmatic methods.

The information related to working capital management of cement companies

have been gathered from the annual reports published of the companies from
year 2011 to year 2015. Annual reports are directly collected from company
official website and national stock exchange. With the information collected,
various ratios components are calculated and interpretations are made through
various statistical models analysis of variance (ANOVA), F-test etc.
Conclusions and findings have been presented along with suggestions to
enhance the effectiveness of working capital management.

Various accounting and statistical techniques have been used in the course of
analysis in the study.

Ratio Analysis: Rationale of this technique is divided into composition

analysis, efficiency analysis and size analysis. A variety of ratios calculated to
evaluate the composition, size and circulation of components of working
capital.

ANOVA: This test the means and variance of means of variables and gives
value of F to conclude hypothesis. In case of derived value of ANOVA
exceeds the F critical value at 0.05, it suggests that the variances are
significant at 5 percent level.

Trend Analysis: To calculate the change in comparative proportion of all

working capital elements, trends are drawn and concluded with suggestions.
This helps to study comparisons among companies and highlight the best
managed company among selected companies.

34